In a recent webinar, Brodies partners Will McIntosh and Eric Galbraith were joined by Tom Baker of Lockton and Iain McCready of Quorum Cyber to discuss emerging trends in M&A deals, the prevalence of warranty and indemnity insurance, how best to maximise returns and achieve a successful exit and finally, a round-up of key deal points and trends.
The big picture
Taking a macro-view to M&A activity since the beginning of the pandemic, Will McIntosh explained that the initial market downturn was abrupt and the volume and value of deals decreased to the lowest point in 25 years. Will further highlighted that M&A transactions are largely about timing, position and sector, and the economic and financial uncertainty caused by Covid-19 disrupted active and proposed deals.
The lull of activity in the M&A market did not last for long and activity picked up dramatically in June 2021, and a main reason for this was the continued growth of cash reserves held by private equity (PE) funds and their drive to continue investing in new deals.
The resilience of the M&A market throughout the pandemic has created a shift in traditional deal norms as new trends have emerged from creative deal structuring to tackle buyer concerns and manage risks:
1. Bridging the gap. To bridge the pricing gap between the seller and the buyer, there has been an increase in the use of earn-outs as a pricing mechanism. This metric includes an initial payment on completion with a deferred payment calculated on the basis of the target company's post completion performance. Additionally, sellers were seen to plug the gap by accepting loan notes from the buyer as an element of the purchase price in order to get deals across the line.
2. Remote diligence. As the pandemic has normalised remote management meetings and investigations, remote diligence is noted as a trend that is here to stay and is more widely accepted.
Warranty and indemnity insurance
Tom Baker of Lockton highlighted that traditionally warranty and indemnity (W&I) insurance was taken out by the sellers and, where there was a claim from a buyer, the seller would introduce the insurers as a third party to the claim. This process has flipped in recent years with W&I insurance becoming aligned with traditional M&A norms and transaction speeds. The buyer in a transaction will now take out the insurance in its own name and will use this as first recourse for a claim under the transaction documents, without engaging the seller.
Brokers will work with legal advisors to frame the main transaction document in a way that is insurable and take this to a market of insurers to see who is best placed and willing to cover the warranties and indemnities.
The prevalence of W&I insurance in M&A transactions has had a profound effect on how deals are structured, and the W&I insurance market has noticed this, with premiums slightly increasing due to the volume of M&A activity and capacity constraints over the pandemic.
How to achieve a successful exit: 3 golden rules
Sharing his wealth of management experience, Iain McCready of Quorum Cyber highlighted three crucial factors to consider when planning an incoming investment or an exit:
1. Understand your end goal. If investment, is the goal to secure seed funding or more significant funding to grow the business? Are the goals of the management team and investors aligned? If a sale, does the management team wish to remain involved in the day-to-day running of the business or to exit entirely? Knowing the answers to these questions are essential to ensure the deal runs as smoothly as possible. This will have a bearing on how you approach the deal and what type of financing or structure is sought.
2. Choose the right advisor(s). An advisor who knows and understands your business and industry will be best placed to ensure the best possible outcome. There are a huge number of unknowns, especially for those who have never been involved in an exit before. An advisor with a wealth of experience of completing deals in your sector can be invaluable in ensuring the deal runs smoothly.
3. Keep the management team small. The management team may have offers from various potential buyers/investors. As an individual, considering the pros and cons of each can be difficult, which can only become more difficult for a large management team, and in some cases may feel impossible! Restricting decision making to a small part of the management team, for example the Chief Executive and Finance Director, can make it easier to clarify your objectives and to make decisions.
A round-up of certain key deal points and trends
Will McIntosh has analysed numerous deal market studies (such as on deal norms in the US and the EU) and highlighted the following key points when dealing with an overseas buyer:
1. Knowing the deal norms on either side of the channel. You can adapt your strategy depending on who the potential buyer is and maximise the outcomes, both in terms of price, how they will view the deal and the risk you take on the back end (such as what you will end up giving back through a price adjustment mechanism or through warranties generally).
2. Having the right conversations. Comparing the UK to the US, it is a bit of a mix in terms of the areas which are seller favourable. If you can mix and match in the right way and have the right conversations, you can end up with a stellar result. If you mix and match in the wrong way, you can end up with a very poor result. It is therefore handy to know where the other side is coming from and to ensure key aspects of the deal are not misunderstood.
The continued globalisation of deals has meant international deal flow has increased and the market has witnessed an influx of US deal norms which have similarity to the EU, creating greater fluidity of deal norms and scope for greater flexibility.
If you are considering a sale or investment and wish to work with an advisor with experience of contemporary deal norms to maximise the best result for you, please get in touch with your regular Brodies contact or one of the contacts listed below.